“Know Your Client Rule” Takes on New Importance
THE RULE
When asked to speak on the impact of technological changes taking place in the retail stock market on the "Know Your Client Rule", I was somewhat at a loss in that if you had asked me several months ago what "Surfing the Net" meant I would have thought it was a surf in the Hawaiian Islands! I am very familiar with the Know Your Client Rule having acted as defence counsel for one of Canada 's largest brokerage firms for a number of years. I have endured the brunt of Judicial tongue lashing for failure of investment advisors to adhere to that Rule. If I have heard it once, I have heard it judicially stated a dozen times, that investment advisors and dealers are "Not Just Order Takers" . In a recent article by one of my colleagues at the Bar, the relationship between the broker (I shall use throughout this article the lay person's terminology of broker rather than the legal terminology of investment advisor or registered representative) and client was described as follows:
"Nevertheless, one of the fundamental relationships in the stock market – that between stockbroker and client has not changed significantly in the last 65 years. It is a relationship essentially verbal in nature, built fundamentally on trust, dependent in large measure on tradition, mystique, salesmanship, puffery and occasionally greed and it is relationship that sometimes ends up in the Courts, often in cases involving perverse facts and unusual litigants". [1]
Judicially, the relationship of a broker to one's client has been described as:
"The relationship was one in which in return for a fee, the Defendants were to give the Plaintiffs advice and to execute the client's orders". [2]
For a broker to fulfill one's obligation to provide advice the broker must know the client's circumstances. It is for that reason that the "Know Your Client Rule" exists. The Rule can be found within the Security Act regulations, TSE By-laws and is stated within the Investment Dealer Association ("IDA") Regulations as follows:
"Regulation 1300.1 – Each Member shall use due diligence:
(a) to learn the essential facts relative to every customer and to every order or account accepted;
(b) to ensure that the acceptance of any order for any account is within the bounds of good business practice; and
(c) to ensure that recommendations made for any account are appropriate for the client and in keeping with his investment objectives." [3]
Under IDA Regulation 1300.2 Member firms are required to designate a director, partner or officer responsible for the opening of new accounts and the supervision of account activity. It is the failure to fulfill these duties that causes defence counsel in stock brokerage cases the greatest difficulty in fending off Plaintiffs' claims for substantial damages. Rest assured that when the client is making money the advice given by the broker is always suitable and in accord with the client's stated investment objectives. It is only when losses are sustained and the client is referred to the counsel who usually handle stock brokerage cases for Plaintiffs (the names of whom I am sure you are well aware) that we hear allegations such as "given the Plaintiff's circumstances the transaction was not suitable or in accord with the Plaintiff's stated investment objectives" or "the Defendant investment dealer failed miserably to properly supervise the Plaintiff's account in breach of its duty of care."
[1] Peter C. Wardle, Playing the Market: An Exploration of Stockbrokers' Liability for Clients' Losses, (1996) 27 Canadian Business Law Journal at page 324
[2]Maghun v. Richardson Securities of Canada Ltd. (1986), 58 O.R. (2d) 1 (Ont. C.A.) per Brooke, J.A. at page 14
[3]Constitution, By-Laws and Regulations, Investment Dealers Association of Canada, Regulation 1300, Supervision of Accounts
